How To Effectively Structure Your Real Estate Investments

One of the most popular articles on real estate I’ve written is about properly setting up the structure for real estate investments from three years ago. It’s caused some controversy since then and I was recently asked if my opinion has changed. Before I get into that, let me tell you a bit about my philosophy on setting up and structuring real estate investments.

I recommend what I call a three-tiered system that consists of:

Operating Company – Setup to control the business operation and your day-to-day project management. All your active business components are within this company and also your risk.

Holding Company – This is for building your family wealth. The holding company owns the operating company so we can strip residual income up into the holding company on a tax-deferred basis via dividends and then allow the holding company to acquire assets.

Property Company – The use of this is for acquiring real estate on behalf of the holding company. Each property with a significant amount of risk may need its own company so that it does not put the others at risk.

The advantage of this particular structure is that you make sure there is never any risk in the holding company because it holds shares of companies with no direct assets. The “property” company and the operating company are the risk companies, meaning if something went sideways, like a tenant suing the property, you could lose the assets that are left in those companies. In general, all the value is kept in the holding company and safe.

Why You Want a Three Tiered System

First off, this structure is only useful if you are someone that plans on being in the business of real estate. If purchasing the home you live in is the extent of your real estate investing goals, this system is not for you.

I suggest this system for any investor that’s purchasing apartments, commercial properties and multi-family homes to maintain a high level of protection from liability.

Is It Right For You?

Since I first wrote about this structure three years ago, a lot has changed in the real estate world, including taxes associated with it. That said, I don’t think anything has changed in my structure and I continue to recommend it because the foundation is still solid.

It’s surprising that over the years that things change so much but some things still work and that’s the case here. I think you need to work with your advisor and make sure it is right for you.

Other experts have rebutted me on my structure and, depending on the circumstances of the investor in question, they may not necessarily be wrong. There are different reasons for everyone on how to set up structures and it’s important to take that into consideration.

Credibility To The Opposing Argument

When you look at the rebuttals to this structure, most of them are due to people who have a hobby of real estate and are not running a business of real estate. There’s a huge difference.

If you only look at the hard numbers and think it’s wiser to hold property personally, that might be because you won’t make use of the full benefits that the three-tiered structure offers.

You need to decide now if you’re going to dabble in real estate or if you plan to be in the business of real estate investing. Do you plan on purchasing multiple properties down the road? If so, you’ll want to consider the three-tiered structure.

Can It Be Done In Steps?

The good news is that this can be done in steps and it doesn’t have to happen all at once. The starting point depends on the size of the building you’re buying and the type of property management you’re doing. This dictates which steps go first, second and third.

Yes, it’s a lot of banking and work to move the money around but this is for a business – we aren’t talking about personal banking costs. Corporate banking costs are more expensive and that’s just the way it works in the banking industry. It makes it easier for your accountant and bookkeeper to keep track of things if you step it up and flow your funds properly.

Make sure you take records properly and that you’re reporting to your bank, mortgage holders and Revenue Canada appropriately.

How To Set It Up

Given that it’s a large expense to setup, most people wonder if you need to set it all at once. If you are in this game for the short term, it’s probably not worthwhile. If you’re in for the long haul, you want to address it right away.

The biggest feedback I get is the cost of setting it up. Sure, you can easily incorporate online by yourself for a few hundred bucks but I do not recommend it. The cost of using a lawyer is worth it. They are experts in it and get it right the first time. The problem with doing it online by yourself is that the odds are high that your structure is going to be wrong and will cost you time, money and headaches later on trying to fix it.

If you’re committed to being in the business of real estate investing and you’re in it for the long haul, work with your advisors to setup the proper structure the first time. Although this isn’t a system for someone that’s dabbling, it can be a serious benefit to real estate investors that want to grow their portfolio over time.